The definition of a security found in The Securities Act of 1933–or the effectively identical definition in the Securities Exchange Act of 1934–is "Any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, per-organization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a 'security', or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the forgoing."
Stocks and bonds are securities. A broader and lesser-defined term is “investment contract.” It amorphously encompasses everything from scotch whiskey to earthworms, vacuum cleaners, and even an orchard full of fruit trees. In SEC v W.J. Howey Co., the US Supreme Court defined the term “investment contract” as: A contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.
Where a business or promoter has attempted to skirt around the securities laws, strict compliance with the definition is not always required. For example, the requirement that profits come solely from the work of another is not always required. It should be no surprise that the Securities and Exchange Commission and others look to this definition It’s a catch all. The answer to the question of what is a security, then, is that anything can be a security if it is packaged and sold in a way that leads others to believe that by purchasing the product, they will earn a profit with little or no effort on their part. The edges of the definition will always be hazy, but the core is clear. Any offering to outsiders of an opportunity to invest in a piece of a company, in future profits, or in growth is a security, and the securities laws apply to that offering and every subsequent transaction involving the security sold. While some instruments are clearly securities, the scope of the securities laws is broad and at times unpredictable.
Crowdfunding is the use of the Internet to raise money through small donations from a large crowd of people. The advent of Crowdfunding has renewed interest in the definition of "securities". Crowdfunding has been categorized into five types, distinguished by what investors are promised in return for their contributions: (1) the donation model; (2) the reward model; (3) the pre-purchase model; (4) the lending model; and (5) the equity model. Applying the Howey test, only the lending model and the equity model usually involve a security.
Securities laws apply to every sale of any security, whether or nor the seller knows the property in question is a security. Innocent ignorance is no excuse. If your client or its business plans to sell a security, or anything that would arguably fall within the definition of an investment contract, tread carefully. Securities violations–even innocent securities violations–may be met with severe sanctions ranging from civil judgments and fines to injunctions and even imprisonment.